Construction Risk Insurance Practices In Pakistan

First International Conference on Construction In Developing Countries (ICCIDC I) Advancing and Integrating Construction Education, Research & Practice August 4-5, 2008, Karachi,, Pakistan Construction Risk Insurance Practices In Pakistan Farrukh Arif farrukh@neduet.edu.pk Lecturer, Department of Civil Engineering NED University of Engineering and Technology, Karachi, Pakistan Uneb Gazder Lecturer, Department of Urban & Infrastructure Engineering NED University of Engineering and Technology, Karachi, Pakistan Nida Azhar Lecturer, Department of Urban & Infrastructure Engineering NED University of Engineering and Technology, Karachi, Pakistan Rizwan U. Farooqui (Assistant Professor, Department of Civil Engineering, NED University of Engineering and Technology, Karachi, Pakistan & Ph.D. Scholar, Department of Construction Management, Florida International University, Miami, Florida, USA) Abstract Construction works are hazardous by nature and accidents are frequent and often severe. The annual toll of deaths, bodily injuries and property damage in construction world is very high. Not only this but construction works involve large amount of investment especially in public projects. All of this increases the risk of construction business and makes handling of financial matters more critical. Insurance and Surety are some of the methods utilized by the contractors and client as risk controlling mechanisms. Risk insurance helps the contractor transferring its risk related to unforeseen circumstances which has a potential risk of damage to life, property, material or equipment. The study aims at highlighting the current insurance practices of the construction industry of Pakistan. A distinguishing approach of targeting insurance companies will be used for data collection in this regard. The study will be beneficial for developing sets of recommendation for the construction industry and financial institutions to highlight and improve the shortcomings of the current practices. It will serve as an initiative to academia for further research. Key Words Construction Industry, Risk, Insurance, Risk Transfer 1. Introduction Construction is recognized by many researchers to be among the riskiest of industries all over the world, both in terms of safety of the personnel and security of investment. Construction industry represents a big part of the national investment, which is above 2% of the total GDP i.e. the direct 177

contribution of the industry while it gets above 10% if the contribution of the transport and communication sector [Federal Bureau of Statistics, Pakistan 2006]. Construction works are characterized by the involvement of man power and the use of equipment and material as the major resources. There are certain risks involved with either types of the resources used. Annual toll of deaths, bodily injuries and property damage in construction world is very high. Not only this but construction works involve large amount of investment especially in public projects. All of this increases the risk of construction business and makes handling of financial matters more critical. Insurance and Surety are some of the methods utilized by the contractors and client through out the developed world as risk controlling against these unwanted events. Risk insurance helps the contractor transferring its risk related to unforeseen circumstances which has a potential risk of damage to life, property, material or equipment. (Richard H. Clough, 1986) This study aims at highlighting the current insurance practices of the construction industry of Pakistan. A distinguishing approach of targeting insurance companies has been used for data collection in this regard. 2. An Overview of Overall Insurance Scenerio in Pakistan Insurance business in Pakistan was regulated under the Insurance act of 1938 and administered by Department of Insurance, under the Ministry of Commerce. This act was replaced by Insurance ordinance 2000 in August 1999, in which an Insurance Division is been established to act in place of Department of Insurance under the Securities and Exchange Commission of Pakistan. Apart from establishing the above mentioned autonomous body this ordinance incorporates the following regulations: Capital requirements for life and non-life insurance companies. Setting up minimum solvency margins on time to time basis. Investigation and issuance of directives for enforcement of Insurance law. Take care of the policyholders interests and judicial administration of the company by enforcing penalties for intervention to law. Registration of the insurers. Implement disclosure and accounts requirements. Setting up of committees and tribunals for taking care of above issues. Division is still in process to take care of some of the above issues [SECP, 2000]. Insurance Association of Pakistan was established in 1948 to work as a forum for the exchange of knowledge, experience and statistics among member companies. Association has affiliation with Ministry of Commerce and is a member of Federation of Pakistan Chambers of Commerce and Industry; it also has its affiliation with international associations. The member companies of the association consist of 32 General insurance and 4 Life insurance companies including 4 foreign companies (2 General and 1 life insurance) up till Feb. 2008 [Insurance Association of Pakistan, 2008]. Insurance industry in Pakistan has been on a high with an average increase in gross premiums of 16% from 1972 to 2006. In the recent years this average has been going up with growth rates above 20%. The Gross premium in 2006 was over Rs. 27.4 billion in which the engineering and transport sector contribution was Rs. 16.35 million which is more than 50% of the total. This certainly indicates the awareness in the engineering and in particular construction engineering 178

sector regarding insurance as risk transfer tool. Still, there exists a need to investigate the risk insurance practices in the construction industry which this study has tried to address. 3. Research Scope & Objectives The study is intended to highlight the involvement and practices of insurance companies in construction industry of Pakistan. In this regard general insurance companies from major cities of Pakistan have been surveyed regarding the construction risk insurance practices. It is anticipated that the information gathered through the study and recommendations will serve as a positive step in highlighting improvements in Construction risk insurance practices and will be valuable in the future. 4. Research Methodology Firstly, a thorough Literature review has been done to determine the current status of the overall insurance practices in Pakistan and particularly the construction risk insurance practices in the developed world. The literature review also helped in developing a questionnaire to investigate the current construction risk insurance practices. A questionnaire has been developed that mainly inquired the Construction Risk Insurance practices and system of the insurance firms. A survey has been conducted from 21 General Insurance companies through out Pakistan. Out of 21 companies the data provided by 10 companies (response rate 48%) was found valid for the analysis. The information gathered through the survey has then been analyzed and some Conclusions and recommendations have been presented on the basis of this analysis. 5. Analysis and Discussion A discussion and analysis of the findings of this study are as follows: 5.1 Types of Insurance Coverages Companies were asked to identify the insurance coverages offered by them for construction projects. The different types of coverages offered by the construction firms (with percentages in brackets) are as follows. It has been found that most of the companies deal in General liability (90%), Professional liability (90%), Builder s risk (70%), Worker s Compensation (80%), Equipment (80%), and Auto insurance (70%). While Pollution liability (30%) and Umbrella excess (10%) are coverages are not so common for the construction projects. Reason for fewer companies been interested in Pollution liability might be the little awareness and less priority of the clients as well as the construction firms for the environmental factors in construction Projects. No firm offers Wrapup insurance programs for construction projects. Wrap-up and Umbrella insurance basically cover the overall performance of the projects; reasons for not offering these coverages may be the high probability of failure of construction projects (in terms of cost and time) and the high risk rating of the construction industry. 179

5.2 Significant Factors for issuance of Insurance for Construction Projects Companies were asked to identify significance of different factors on a scale of (1 to 5) with significance increasing from 1 to 5 for issuing insurance coverages to the construction projects. The factors are classified among the following classes: Owner related factors Key Personnel related factors Past Project related factors Company s operation related factors Current Project related factors factors Related to Financial position For all the factors in the above classes a Factor Significance Index (FSI) has been calculated by the following formula. The results are shown in Table 1 FSI = (no of response at each significance x significance weight) No. of Responses for Each Factor Table 1: Factor Significance Indices Factors Factors Significance Index Owner s Related Factors Type of ownership 3.8 Other businesses held by owner 3.8 Information about spouse 1.7 Market reputation of owner 4.1 Life insurance payable to the company 1.6 Past experience with the insurance company 4.5 Factors Related to Key Personnel of Organization Technical Competencies 3.8 Past Experience 3.6 Period of Employment 3.1 Past Project Information Scope of past projects 4.0 Ratio of successful v/s unsuccessful projects 4.0 Size of work handled 3.8 Geographical Location 4.0 Profitability 3.7 Owners and architects of past projects 3.1 Employment Contracts 3.2 Largest Size of Successful Projects 3.6 Factors related to operations of the company Type of work 3.8 Plans of expansion 3.8 Operating Policies and procedures 2.6 Current Project Information Hazardous Material 4.2 Geographical Location 3.7 Terms of Contract 3.9 Method of Payment 3.8 180

Factors Factors Significance Index Percentage of Retention Money 3.2 Volume of Subcontracted Work 3.7 Technical requirements 4.0 Machinery used 3.6 Factors Related to Financial Position of Company Financial Statements of past years 4.0 Financial statement of current year 4.0 Bank Credit record 4.2 Cost Management Book Keeping System 3.2 The top ten factors that were identified as most significant are given as under in the order of descending significance: 1. Past experience with the insurance company (4.5) 2. Hazardous Material (4.2) 3. Bank Credit record (4.2) 4. Market reputation of owner (4.1) 5. Scope of past projects (4.0) 6. Ratio of successful v/s unsuccessful projects (4.0) 7. Geographical Location (4.0) 8. Financial Statements of past years (4.0) 9. Financial statement of current year (4.0) 10. Machinery used (3.6) The factors identified as the most significant are mostly related to the construction firms past performance, reputation and on the hazards related to the current project. Personal, management and contractual information like life insurance, operating policies and procedures, employment contracts, etc, do not seem to gain much attention in risk insurance assessment of construction companies. On the basis of above indices Class Significance index (CSI) has been calculated to compare the significance given to each class by the following formula. The results are shown in Table 2 CSI= (FSIs for each class) No. of Factors in each class Table 2: Class Significance Indices Class Class Significance Index Owner s Related Factors 3.25 Factors Related to Key Personnel of Organization 3.5 Past Project Information 3.7 Factors related to operations of the company 3.4 Current Project Information 3.8 Factors Related to Financial Position of Company 3.9 The class significant indices show that financial status and current project Information are of more concern than other classes of factors. Financial factors are normally used for the risk 181

evaluation of a company by almost all stakeholders because they are easier to establish and interpret. 5.3 Criteria for Premium Rates Companies were asked to identify the criteria for setting up the premium rates for different types of insurance coverages on construction projects. Table 3 shows the percentage of companies that consider a particular factor as important. From this table we can conclude that Classification of operations and probable accidents associated with those operations are the most considered factors for defining the premium rates. Since both these factors are the variables that define level of risk to a particular job. Insurance Policies Table 3: Criteria for defining premium rates Classification of operations Rates of pay Factors The frequency and severity of accidents in a particular classification Attitudes of various industrial compensation commissions General liability 57.14 % 14.29% 71.43% 42.86% Professional liability 71.43 % 57.14% 57.14% 0.00% Builder s risk 57.14 % 0.00% 57.14% 28.58% Worker s compensation 57.14% 71.43% 57.14% 28.58% Increases in the cost of cases 14.29% 42.86% 14.29% 14.29% Contractor s pollution liability Equipment 57.14% 42.86% 42.86% 14.29% 71.43% 14.29% 71.43% 28.57% The premium rates set by the companies is also based on both the cost of project and time period of project. The usual premium rates set by the insurance companies based on cost of project are shown in table 4 Table 4: Premium rates based upon cost of Project Cost of Project Less than One million One to five million Greater than five million Premium Rate 1% per annum 0.75% per annum 0.5% per annum The premium rates set by the insurance companies based upon the duration of project are shown in table 5 182

Table 5: Premium rates based upon Duration of Project Duration Premium Rate >8 months 1% For 3 months 0.125% For 6 months 0.5% 5.4 Worker s Compensation Insurance For Workers Compensation insurance medical and hospitalization allowances are considered but rehabilitation expenses (which have gained a great importance in USA and Australia) are not considered at all. These rehabilitation expenses also include disability payments in most cases which are also not covered by many companies. In most of the cases Worker s compensation does not include professional diseases, this is a concept that is been greatly considered by developed countries to not only look at the immediate losses but long term losses due to increased exposure to the field, environment and material. All these factors are considered to be awkward components of the construction industry which keep on changing from project to project. There is no preference for premium rating system of Worker s Compensation both Retrospective and guaranteed cost are equally used. In case of injuries or illnesses hospitalization expenses are covered or predetermined amounts are also given for disability but no income is given for disablement period which is a part of rehabilitation process. For calculating the premium amount Payroll and Craft of the employee are considered. 5.5 Reporting Authority Companies have given a mixed response for the reporting of incidents/accidents indicating the lack of regulatory framework. Although an Insurance Division is established to regulate the insurance industry but most respondents have identified local and provincial governments for reporting of these incidents and insurance related matters. 6. Conclusions Following are the major conclusions drawn from the findings of the study: 1. The insurance policies provided in Pakistan for construction projects are General liability, Professional liability, Builder s risk, Worker s compensation and equipment coverages. 2. The findings of the research have signified that although there is strong existence of insurance mechanism in Pakistan but insurance practices don t seem to be deep rooted in the construction industry. 3. The top five Factors that have been found most significant for issuance of insurance for construction projects are: a. Past experience with the insurance company b. Hazardous Material c. Bank Credit record d. Market reputation of owner e. Scope of past projects 183

All the above factors are mostly related to past performance of the companies. Since, there is no mechanism in which past performances of the construction projects are recorded the measurement of these factors are difficult for the insurance firms. 4. Financial factors seem to have the greatest importance for insurers for issuance of Policies. 5. Classification of operations and the frequency and severity of associated accidents were found as the most dominant factors for establishing premium rates for any policy. In turn these factors also decide about the associated risk for a particular job. 6. No dominant premium rating system exist for any insurance coverage although industry related factors like severity of past accidents and operations of the company look to be more rated high than other factors. 7. Premium rates vary a lot from organization to organization but range for the rates for all policies seem to fall in a small range for particular organizations. 8. Worker s compensation is mostly provided for the medical and hospitalization expenses of accidents or a fixed amount for disability. Issues related to rehabilitation of the worker are being greatly neglected. 9. No single reporting authority was pointed out by the respondents. Mostly local or provincial government body has been found as the reporting agency instead of the Insurance division which is being specifically established insurance regulation. 7. Recommendations The findings of the research has shown strong existence of insurance practices in Pakistan in General scenario but still insurance as a risk transfer tool is not at mature stage in Construction works. There are some weaknesses in the insurance system that are needed to be overcome. There is a strong need of a mechanism that can measure the past projects performance of construction firms. The worker s compensation should address to the issue of worker rehabilitation. There should be a single reporting and monitoring authority. 8. References Federal Bureau of Statistics-National accounts of Pakistan Insurance association of Pakistan (IAP)-www.iap.net.pk Kangari & Bakheet (2001) Construction Surety Bonding Journal of Construction Engineering and Managegment., Volume 127, Issue 3, pp. 232-238 Richard H. Clough (1986) Construction Contracting 5th edition, John Wiley & Sons New York. Securities and Exchange Commission of Pakistan (SECP) annual report 2000, Regulation of Insurance. 184